How to Get Your Kids to Invest in Mutual Funds
The best mutual funds for children are similar to the best mutual funds for any other new investor. Setting some basic goals, opening a minor account, and selecting the right type of fund to meet the investment objective are the first steps in getting kids started with investing.
We'll go over the best types of accounts and mutual funds to get kids started with investing and help them learn as they go in this article.
What Are the Best Types of Investment Accounts for Children?
Some investment accounts are specifically designed for children, whether to fund college, leave a legacy gift, or secure the child's future.
If the child is below the age of 18, they will most likely require a minor account to begin investing. Minors may be able to open their retirement accounts in some cases. A parent, for example, can open an investment account on behalf of their minor children. These accounts are typically used to save for school or other long-term goals.
Minor children are not allowed to open savings (or checking) accounts by law. You can set up an account that is the child's property but remains under your management until they turn 18 by acting as a custodian. Another option is to open a joint account that you and your partner will share.
The following are the most common types of accounts that minors can use to invest in:
UGMA/UTMA: Accounts established under the Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA) can be used to invest in securities on behalfs of a minor, such as stocks, bonds, or mutual funds. Which state you live in determines whether you open a UGMA or a UTMA.
If a child has earned income, he or she may be eligible to open a Roth Individual Retirement Account (IRA). They could start their own IRA and start saving for retirement if they do yard work for neighbors or have a small summer job and claim this income on their tax return.
ESA (Education Savings Account): This account, also known as a "Coverdell Education Savings Account," is a trust that is used to save for college. It can also be used for various college-related expenses, such as books, supplies, and occasionally even room and board. Withdrawals are tax-free as long as the money is put towards these qualified expenses. An adult acting as the child's custodian opens an ESA account on the child's behalf. The trustee is only allowed to contribute up to $2,000 per year.
529 Savings Plan: The 529 plan, also known as a "qualified tuition plan" (QTP), is similar to an ESA in that it is used to fund a child's future education. The 529 plan, unlike the ESA, is not a trust that passes to the child; instead, it remains in the name of the adult who established it. States sponsor 529 plans, which are made possible by Section 529 of the federal tax code. These plans provide state-specific tax benefits and investment options.
Warning: The state typically imposes strict rules on accounts designed for children to prevent adults from taking advantage of them. One way to enforce contribution limits and account spending is to impose severe tax penalties.
Children's Investing Can Begin With Just One Mutual Fund
If you want to keep things simple and invest in just one fund, there are a few options that work well in terms of cost and risk:
Index Funds: Funds that track a broad market index, such as S&P 500 index funds, can be an excellent place to begin investing in mutual funds. That's because most of these funds have low expense ratios, which means they're cheap to manage, and they're spread across dozens or even hundreds of stocks; a single fund could include stocks from companies in a variety of industries. Some of the most well-known index fund companies include Vanguard, Fidelity, T. Rowe Price, and Charles Schwab.
Balanced Funds, also known as "hybrid funds" or "asset allocation funds," invest in a diverse portfolio of stocks, bonds, and cash. The allocation is usually fixed, and the professionals in charge of the funds adhere to a stated goal or style. This mix of stocks and bonds provides a lot of variety in a single fund.
Target Date Mutual Funds: Also known as "life-cycle funds" or "target retirement funds," target date mutual funds invest in a combination of stocks, bonds, and cash to best suit the needs of someone planning to retire a specific year or decade. As the target date approaches, the fund manager will reduce market risk by shifting assets out of stocks and into bonds and cash, as a prudent investor would do on their own.
How Can Kids Begin Investing With $50 or Less?
Some mutual funds have the disadvantage of requiring money up front to fund your account. To get started, the minimum investment can be as much as $1,000 or more, but there are less expensive options.
Here are some diversified mutual funds that require a $50 minimum investment:
- The Schwab Balanced Fund (SWOBX) invests in a combination of stocks and bonds. There is no requirement for a minimum initial investment.
- Fidelity 500 Index Fund (FXAIX): This fund invests in approximately 500 of the largest U.S. companies, following the S&P 500 index. There is no requirement for a minimum initial investment.
- Target retirement funds, such as USAA Target Retirement 2060 (URSIX), can be set up for people who have a rough idea of when they will retire. This fund is designed for people who plan to retire in 45 years or less; it begins with a stock-heavy portfolio and gradually shifts to bonds as the target year approaches. The initial investment is only $50 when combined with a structured plan.
One of the best reasons for kids to open a mutual fund account is the old adage "time is money." Because of compounding, even small investments have the potential to grow over time and at ever-increasing rates. Children have the benefit of many years to watch their account balances rise.
Final Thoughts
To get kids started investing, there are various account options and mutual fund types to choose from. From adult-sponsored education savings accounts to IRAs in the child's name, children can benefit from compounding returns and accumulate wealth over time. Make sure to select the account types and mutual funds that are best suited to your child's objectives.
Most Commonly Asked Questions (FAQs)
How do you set up a child's custodial account?
The process of opening a custodial account for a child is similar to that of opening any other account. Only the most basic information about yourself and the child is required. If the custodial account is a mutual fund investment account, you'll need to link one of your existing bank accounts in order to add funds.
Who pays taxes on a child's custodial account's mutual fund profits?
The money in a custodial account belongs to the minor. As a result, the child would be responsible for paying taxes on any capital gains or distributions from mutual funds held in the custodial account; however, custodial accounts are subject to different tax regulations. Unearned income from these accounts is tax-free up to $1,050. The next $1,050 is taxed at a lower rate for children. After the first $2,100, the income is taxed at the federal tax bracket rate of the parent or guardian.
We do not offer or advise on tax, investment, or financial services. The information is being provided without considering any specific investor's investment objectives, risk tolerance, or financial circumstances and may not be suitable for all investors. Past performance does not guarantee future outcomes. Investing entails risk, including the possibility of losing money.
